RJR Nabisco

Lawyers at the gate

THE senseless high-stakes auction of the merged RJR Nabisco was seen as one of the most glamorous episodes on Wall Street in the decadent late 1980s; the sensible decision to demerge has been greeted with a yawn. RJR's share price barely budged when the announcement came, on March 9th, that the company which makes Camel cigarettes and Oreo cookies was selling its international tobacco subsidiary and planned to split its domestic cigarette and food businesses.

On the face of it this lack of enthusiasm looks perverse. Everyone from RJR's own boss to corporate raider Carl Icahn, who has built up a 7.7% stake in RJR, agrees that tobacco and food do not belong under one roof. Steven Goldstone, RJR's chief executive, admits that while there are some synergies, “cookies and cigarettes do not share distribution or marketing or even the same sales forces. They are very, very different businesses.”

The obstacle to splitting the two has been the tobacco lawsuits still hanging over the company. A simple demerger, Mr Goldstone feared, would lead litigants to argue that RJR was illegally reducing its asset base from which claims could be paid. So instead, the tobacco business, R.J. Reynolds, has been spun off, but the food business will still be owned by the current holding company. That means it may still be vulnerable to the massive damage claims that will continue to be filed against it. “Plaintiffs have no reason to squeal,” says Martin Feldman, tobacco analyst at Salomon Smith Barney. “This makes absolutely no difference to their ability to bring claims against the company.”

The domestic tobacco business can stand alone because Mr Goldstone also unloaded RJR's weak international tobacco arm for $8 billion. The industry did not expect RJR to get much more than $6.5 billion, but Japan Tobacco, the buyer, needs to expand internationally. The group has thus been able to reduce its crippling debt from around $6.5 billion to $1 billion.

If it all works to plan, the spin-off should unlock substantial value. RJR is currently trading at around $30 a share, which is the value of its 80.6% Nabisco stake at current prices. Tobacco is, in effect, valued at nothing. Mr Feldman calculates that a demerged domestic tobacco business should be worth another $14 to $16 a share.

So why have investors failed to appreciate this? Somewhat lamely, Mr Goldstone blames the sheer complexity of the deal. “I think there's a lot of confusion, ” he complains. Others point the finger at the lawyers. “This is America,” explains Tim Ghriskey, head of value equities at Dreyfus, one of RJR's shareholders. “Tobacco lawyers go after everything and this deal does not change the risk.”

Analysts reckon that the food assets' exposure to tobacco claims will leave shares in the new Nabisco holding company trading some 20% lower than the Nabisco shares, which are not owned by RJR and are therefore not threatened by lawsuits. Moreover, as Mr Goldstone admits, by reducing its debt, this deal could make R.J. Reynolds look an even juicier target for litigants.

A further sticking point may be an impending lawsuit against the tobacco industry out of Cleveland, Ohio, that is worth $2 billion and could be heard next week. Obviously, investors will have to wait for the smoke to clear.